A total of 152 borrowers’ credit grades or outlooks were
cut in the first nine months of this year, exceeding 73 for the
whole of 2012, according to data compiled by Haitong. The yield
on Anyang Iron & Steel Co.’s 2019 notes has jumped 396 basis
points to 10.8 percent since China Chengxin Securities Rating
Co. reduced its ranking to AA- from AA on June 28. Globally,
fallen angels, or notes downgraded to junk, pay 4.9 percent,
Bank of America Merrill Lynch indexes show.

Investors are demanding higher yields to buy lower-rated
debt after authorities ordered 1,400 companies in 19 industries
including steel to cut capacity. Policy makers will outline more
market reforms at a Communist Party summit next month. Chinese
companies rated at AA-, considered speculative-grade in the
country, must pay 313 basis points more than the government on
five-year securities, near the most in more than five months.

“Capacity reduction may cause some companies to go
bankrupt,” said Li Ning, a bond analyst at Haitong Securities
in Shanghai. “Risks in steel, nonferrous and coal industries
are rising.”

There is an increased chance that more credit ratings will
be cut and those companies’ bond yields will rise above 10
percent, Li said.

Concerns Mount

There have been no defaults in the publicly traded domestic
debt market since the central bank started regulating it in
1997, according to Moody’s Investors Service. Concerns have
mounted since the biggest unit of Suntech Power Holdings Co.
went into bankruptcy in March after defaulting on $541 million
of offshore bonds. The next month, LDK Solar Co. failed to fully
repay $23.8 million in dollar-denominated securities.

The rate on Jilin Provincial Coal Industry Group Co.’s 2016
yuan bond has risen 59 basis points to 6.16 percent since China
Chengxin International Credit Rating Co. cut the borrower’s
rating from AA+ to AA on Sept. 26, according to Chinabond data.

Christopher Lee, managing director of corporate ratings at
Standard & Poor’s in Hong Kong, said last month Chinese
companies will miss more debt payments in the coming year as the
government switches the economy’s focus toward services.
Companies in metals, mining, building materials, coal and
transportation industries have elevated credit risks because
their leverage is high and their capacity to service debt is
low, according to Lee.

Default Watch

Long-term slowing of the world’s second-biggest economy is
also increasing credit risks, and downgrades may reach another
record next year, according to Haitong’s Li.

“The first onshore default is drawing near,” Li said.
“It’s possible it could happen next year.”

While growth in gross domestic product accelerated to 7.8
percent in the third quarter, it still extended the longest
streak of sub-8 percent growth in at least two decades.
Industrial manufacturing and fixed-asset investment all slowed
in September. Economic expansion will cool to 7.6 percent this
year from 7.7 percent in 2012, before falling further to 7.4
percent next year, according to the median estimate of
economists surveyed by Bloomberg.

‘Downward Trend’

“The economy is on a downward trend and some companies
will see further deterioration in earnings,” said Dong Hui, a
bond analyst at China Securities Co. in Beijing. Steel, coal,
shipping and solar industries are facing the highest risks, he
said.

Credit-default swaps insuring China’s debt against non-payment have increased 17 basis points this year to 83 basis
points, according to data provider CMA.

Some market movements have pointed toward increasing
economic confidence. As investors shift toward riskier assets,
the rate on China’s benchmark 10-year government bond climbed to
a more-than-five-year high of 4.22 percent on Oct. 25. The yuan
traded at 6.0872 per dollar earlier today in Shanghai, near the
20-year high it marked last week at 6.0802, the strongest level
since the government unified the official and market exchange
rates at the end of 1993.

The government is more strictly monitoring Chinese rating
companies’ accuracy and timeliness, which may prompt the credit
assessors to take more cautious stances in reviewing borrowers,
according to Haitong’s Li. The China Securities Regulatory
Commission’s Shenzhen branch issued a warning on Aug. 2 to
Pengyuan Credit Rating Co. saying it hadn’t released rating
reports on Shanghai Chaori Solar Energy Science & Technology Co.
in time.

“The probability of the first onshore bond default is
rising,” said Yang Feng, a bond analyst in Beijing at Citic
Securities Co., the nation’s biggest brokerage.